The Money Markets Mess

What happens when people try to withdraw money from money market funds: Money market funds will sell your shares out of your money market account to raise the cash. Remember, in almost all money market funds one share = $1. To raise that money the fund usually draws from the cash that they have on hand that day. This cash comes from the vast array of short term securities (usually 90 day or less commercial paper) that a fund has maturing on any given day. If they don’t have enough cash from maturing securities they then will sell some of the funds assets to raise the needed cash (remember this point, I am will circle back to it). If they can’t for some reason or don’t want to sell assets to raise the cash then they will draw their massive lines of credit that they have with various banks. Then there is overnight lending and inter-fund lending (see WSJ article on the recent squabble between HSBC and Barclays).

Lack of transparency:

Many of the commercial paper securities are not transparent enough for us to evaluate their risk. I would say that it is fair to say the most money market funds use commercial paper made of ABS. Here is where the infamous CDO’s come into play. An August 22 Bloomberg article notes that out of all CDO’s sold in the U.S., half contain sub-prime. When asset back securities make a large portion of most money market portfolio’s one most take notice.

You may have read responses from money market managers maintaining that they hold no sub-prime securities and that all of their securities are “tier one rated”. We are not disagreeing with money market mangers claim that they only hold top quality paper, however one must remember that these “securities” are just a bundle of other investments that have been given a cumulative rating of “tier one” by rating agencies.

I believe that we should not base our investment decisions solely on credit agencies ratings. According Bloomberg 90% of CDO’s get rated AAA or Aaa. The higher the credit rating the lower the return that is demanded by, by us, the investor. Therefore, yes the paper is “top tier”, however CDO’s may contain individual pieces may not be by themselves considered tier one paper.

Reliable sources of statistical information do not exist. Former SEC chairmen Harvey Pitt says quote,” The bottom line is that relying on rating agencies, in the case, may leave investors a day late and dollar short”

I have heard the SEC allows any “money market fund” to contain as much as 5% of tier two rated paper. If any one can find a source confirming that please leave a comment or email me at jwcuse@gmail.com.

The fear factor and the Nightmare Scenario: Regardless of whether or not it is true, the commercial paper market far less liquid. According Bloomberg, CDO sales have slumped to 11.9 billion in July from 36.9 billion in June.

Now let’s get back to the beginning. What if people actually get so scared that massive amounts of people move to straight treasuries or Treasury only money market fund? Money market funds would surely not have enough commercial paper maturing to cover the demand for cash. Furthermore they would then have to surely try to sell large portions of their assets. The problem that market cannot price these ABS’s. David Rosenburg, a Merrill Lynch economist, has repeatedly reported that he has heard from a variety of sources that the ABS commercial paper market has essentially dried up! There is no liquidity folks, so how could they possible sell to cover the redemption demand? At this point then money market funds would have to tap their vast lines of credit, but with such a huge demand for cash who knows how the banks would respond.

The good News: Breaking the Buck

All money market funds are try hold a value of $1 per share. Only one money market fund has done what is called “breaking the buck”, which is when the market value of a money market share falls below a $1. Only one money market fund has ever broken the buck, ever!

Look I don’t claim to be an expert on this and I don’t believe that many…if any funds will break the buck. However if one does and it gets the press’s attention, hold on, because at that point your money market fund may be the least of your worries. Please tear holes in my little right up or add your comments to it. The market needs somebody to tell us that the value of this commercial paper isn’t withering away to nothing and this bull run will continue.